UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2014       Commission File Number:  0‑3676

VSE CORPORATION

(Exact Name of Registrant as Specified in its Charter)

 

Registrant's Telephone Number, Including Area Code:  (703) 960-4600

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes     No 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes     No 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes     No 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes     No 

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer  Accelerated filer  Non-accelerated filer  Smaller reporting company 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes     No 

The aggregate market value of outstanding voting stock held by nonaffiliates of the Registrant as of June 30, 2014, was approximately $290 million based on the last reported sales price of the registrant's common stock on The NASDAQ Global Select Market as of that date.

Number of shares of Common Stock outstanding as of March 1, 2015: 5,367,261.

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DOCUMENTS INCORPORATED BY REFERENCE

Portions of Registrant's Proxy Statement for the Annual Meeting of Stockholders expected to be held on May 5, 2015, are incorporated herein by reference into Part III of this report.

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Forward Looking Statements

This Annual Report on Form 10-K ("Form 10-K") contains statements that, to the extent they are not recitations of historical fact, constitute "forward looking statements" under federal securities laws.  All such statements are intended to be subject to the safe harbor protection provided by applicable securities laws. For discussions identifying some important factors that could cause actual VSE Corporation ("VSE," the "Company," "us," "our," or "we") results to differ materially from those anticipated in the forward looking statements contained in this filing, see VSE's "Narrative Description of Business" (Items 1, 1A, 2 and 3), and "Management's Discussion and Analysis." Readers are cautioned not to place undue reliance on these forward looking statements, which reflect management's analysis only as of the date hereof. The Company undertakes no obligation to publicly revise these forward looking statements to reflect events or circumstances that arise after the date hereof. Readers should also carefully review the risk factors described in other documents the Company files from time to time with the Securities and Exchange Commission, including Quarterly Reports on Form 10-Q filed by the Company subsequent to this Form 10-K and any Current Reports on Form 8-K filed by the Company.

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ITEM 1.

Business

(a)   General Background

 

VSE was incorporated in Delaware in 1959 and serves as a centralized managing and consolidating entity for our business operations. Our business operations are managed under groups consisting of one or more divisions or wholly owned subsidiaries that perform our services. VSE's operating groups include our Supply Chain Management Group, International Group, Federal Group, and IT, Energy and Management Consulting Group. The term "VSE" or "Company" means VSE and its subsidiaries and divisions unless the context indicates operations of only VSE as the parent company.

Our business operations consist of vehicle fleet and equipment sustainment services, including supply chain management services, and diversified technical services, including logistics, engineering, IT solutions, health care IT, and consulting services. Our services are performed for the United States Government (the "government"), including the United States Department of Defense ("DoD") and federal civilian agencies, the United States Postal Service ("USPS"), commercial customers, and other clients.

We seek to provide our customers with competitive, cost-effective solutions to specific problems. These problems generally require a detailed technical knowledge of vehicles, equipment, materials, processes, functional characteristics, information systems, technology and products and an in-depth understanding of the basic requirements for effective systems and business operations.

(b)   Financial Information

Our operations are conducted within four reportable segments aligned with our management groups: (1) Supply Chain, which generated approximately 41% of our revenues in 2014; (2) International, which generated approximately 25% of our revenues in 2014; (3) Federal, which generated approximately 20% of our revenues in 2014; and (4) IT, Energy and Management Consulting, which generated approximately 14% of our revenues in 2014. Additional financial information for our reportable segments appears in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and in "Item 8. Financial Statements and Supplementary Data" of this Form 10-K.

(c)   Description of Business

Services and Products

We use a broad array of capabilities and resources to support military, federal civilian, and other government and non-government vehicle fleets, systems, equipment and processes. We are focused on creating, sustaining and improving the vehicle fleets, systems, equipment and processes of our clients through core offerings in supply chain management, equipment refurbishment, logistics, engineering, IT solutions, health care IT, and consulting services.

Typical service offerings include supply chain and inventory management services; vehicle fleet sustainment programs; vehicle fleet parts; engineering support for military vehicles and combat trailers; military equipment refurbishment and modification; ship maintenance, overhaul, and follow-on technical support; logistics management support; machinery condition analysis; specification preparation for ship alterations; ship's force crew training; life cycle support for ships; ship communication systems; energy conservation, energy efficiency, sustainable energy supply, and electric power grid modernization projects; technology road-mapping; IT enterprise architecture development, information assurance/business continuity, security risk management, and network services; medical logistics; and medical command and control. See Item 7 "Management's Discussion and Analysis of Financial Information and Results of Operations" for more information regarding our business.

 

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Revenues and Contracts

Our revenues are derived from contract services performed for DoD agencies or federal civilian agencies and from the delivery of products to our clients. The USPS, U.S. Army and Army Reserve, and U.S. Navy are our largest customers. Our customers also include various other government agencies and commercial entities.

Depending on solicitation requirements and other factors, we offer our products and professional and technical services through various ordering agreements, negotiated and competitive contract arrangements, and business units that are responsive to customer requirements. Some of the contracts permit the contracting agency to issue delivery orders or task orders in an expeditious manner to satisfy relatively short-term requirements for engineering and technical services.

Our Supply Chain Management Group revenues result from the sale of vehicle parts to the USPS and other clients. We recognize revenue from the sale of vehicle parts when the customer takes ownership of the parts.

Our International, Federal, and IT, Energy and Management Consulting Group revenues result primarily from cost plus fee, time and materials, or fixed-price contracts with the government. Revenues result from work performed on these contracts by our own employees, from work performed by our subcontractors, and from costs of materials used in performing the work. Revenues on cost-type contracts are recorded as allowable costs are incurred and fees are earned.

Revenues for time and materials contracts are recorded on the basis of allowable labor hours worked multiplied by the contract defined billing rates, plus the cost of materials used in performance on the contract. Profits or losses on time and material contracts result from the difference between the cost of services performed and the contract defined billing rates for these services.

Revenue recognition methods on fixed-price contracts vary depending on the nature of the work and the contract terms. Revenues on fixed-price service contracts are recorded as work is performed, typically ratably over the service period. Revenues on fixed-price contracts that require delivery of specific items are recorded based on a price per unit as units are delivered.

Backlog

Funded backlog represents a measure of potential future revenues from our government contracts. Funded backlog is defined by us as the total value of contracts that has been appropriated and funded by the procuring agencies, less the amount of revenues that have already been recognized on such contracts. Our reported backlog is comprised of funding received by us in incremental amounts intended to fund work that is generally expected to be completed within six to 12 months following the award of the funding. Accordingly, substantially our entire reported backlog is reasonably expected to be filled within this time. Our funded backlog as of December 31, 2014, was approximately $195 million. Funded backlog as of December 31, 2013 and 2012 was approximately $236 million and $250 million, respectively. Changes in funded backlog on contracts are sometimes unpredictable due to uncertainties associated with changing government program priorities and availability of funds, which is heavily dependent upon the congressional authorization and appropriation process.  Delays in this process, such as those experienced in recent years, may temporarily diminish the availability of funds for ongoing and planned work.

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In addition to the funded backlog levels, we have contract ceiling amounts available for use on multiple award, indefinite delivery, indefinite quantity contracts with DoD and federal civilian agencies. While these contracts increase the opportunities available for us to pursue future work, the actual amount of future work is indeterminate until delivery orders are placed on the contracts. Frequently, these delivery orders are competitively awarded. Additionally, these delivery orders must be funded by the procuring agencies before we can perform work and begin generating revenues.

Marketing

Our marketing activities are conducted at the operating group level by our business development and marketing staff and our professional staff of engineers, program managers, and other personnel. Information concerning new programs, requirements and opportunities becomes available in the course of contract performance, through sales calls and client servicing, through negotiation with key business partners, through formal and informal briefings, from participation in professional organizations, and from literature published by the government, trade associations, professional organizations and commercial entities.

Personnel

Services are provided by our professional and technical personnel having high levels of education, experience, training and skills. As of December 31, 2014, we had 1,589 employees, a decrease from 1,872 as of December 31, 2013. Principal employee categories include (a) mechanics and vehicle and equipment technicians, (b) information technology professionals in computer systems, applications and products, configuration, change and data management disciplines, (c) engineers and technicians in mechanical, electronic, industrial, energy and environmental services, (d) logisticians, (e) environmental specialists, and (f) warehouse and sales personnel. The expertise required by our customers frequently includes knowledge of government administrative procedures. Approximately one-third of our employees have previously served as members in the U.S. Armed Forces.

Competition

The professional and technical services industry in which we are engaged is very competitive. Numerous other organizations, including large, diversified firms, have greater financial resources and larger technical staffs that are capable of providing the same services offered by us.

Government agencies emphasize awarding contracts on a competitive basis as opposed to a sole source or other noncompetitive basis. Most of the significant contracts under which we currently perform were either initially awarded on a competitive basis or have been renewed at least once on a competitive basis. Government agencies also order services through contracts awarded by the General Services Administration ("GSA"). GSA provides a schedule of services at fixed prices that may be ordered outside of the solicitation process. We have seven GSA schedule contracts for different classes of services. There is no assurance regarding the level of work we may obtain under these contracts. Government budgets, and in particular the budgets of certain government agencies, can also affect competition in our business. A general decline in government budgets, or a reallocation of government spending priorities that results in lower levels of potential business in the markets we serve or the services we offer, will cause increased competition. Further, contract awards frequently are protested to the Government Accounting Office ("GAO").

The extent and range of competition that we will encounter as a result of changing economic or competitive conditions, customer requirements or technological developments is unpredictable. We believe the principal competitive factors for our business are technical and financial qualifications, past performance, government budgetary stress, and price.

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Available Information

Copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports are filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. They are available free of charge through our website www.vsecorp.com as soon as reasonably practicable after the reports are electronically filed with the Securities and Exchange Commission ("SEC").

ITEM 1A.  Risk Factors

Our future results may differ materially from past results and from those projected in the forward-looking statements contained in this Form 10-K due to various uncertainties and risks, including but not limited to those risks set forth below, non-recurring events and other important factors disclosed previously and from time to time in our other reports filed with the SEC.

Uncertain government budgets and shifting government priorities could delay contract awards and funding and adversely affect our ability to continue work under our government contracts. Additionally, federal procurement directives could result in our loss of work on current programs to set-asides and large multiple award contracts.

Our government business is subject to funding delays, terminations, reductions, extensions, and moratoriums caused by the government's budgeting and contracting process. The federal procurement environment is unpredictable and could adversely affect our ability to perform work under new and existing contracts. Contract award and funding delays extend across the federal technical services industry. We experienced delays in contract awards and funding on our contracts in recent years that have adversely affected our ability to continue existing work and to replace expiring work. Additionally, our government business is subject to the risk that one or more of our potential contracts or contract extensions may be awarded by the contracting agency to a small or disadvantaged or minority-owned business pursuant to set-aside programs administered by the Small Business Administration, or may be bundled into large multiple award contracts for very large businesses. These risks can potentially have an adverse effect on our revenue growth and profit margins.

Increased market competition resulting from decreases in government spending for contract services and government contracting award criteria could adversely affect our ability to sustain our revenue levels.

Continuing pressure on government budgets may adversely affect the flow of work to federal contractors, particularly new programs. Consequently, competitor contractors that experience a loss of government work have tended to redirect their marketing efforts toward the types of work that we perform.  This increase in competition for our service offerings has adversely affected our ability to win new work or successor contracts to continue work that is currently performed by us under expiring contracts. Disappointed bidders frequently protest contract awards, which can delay or reverse the contract awards. Additionally, the government has trended toward contract award criteria that emphasizes lowest price, technically acceptable bids, which further intensifies competition in our government markets.

Our business could be adversely affected by incidents that could cause an interruption in our operations or impose a significant financial liability on us.

Disruption of our operations due to internal or external system or service failures, accidents or incidents involving employees or third parties working in high-risk locations, or natural disasters or other crises could adversely affect our financial performance and condition. Our Managed Inventory Program ("MIP") that supplies truck replacement parts for the United States Postal Service ("USPS") fleet, our Foreign Military Sales ("FMS") Program for the U.S. Navy, and our vehicle and equipment refurbishment work for the U.S. Army Reserve are our three largest revenue generators, accounting for 38%, 20%, and 11% of our 2014 revenues, respectively. A fire, flood, earthquake, or other natural disaster at physical facilities that support these operations, or a procurement system or contractual delay such as we experienced on our U.S. Army Reserve contract in 2013, could potentially interrupt the revenues from our operations.

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Certain programs comprise a material portion of our revenue.

Our USPS MIP, FMS Program, and U.S. Army Reserve vehicle and equipment refurbishment work constitute a material portion of our revenues. This concentration of our revenue in a few key programs subjects us to risk of material adverse revenue disruptions if USPS operational decisions, government contractual, or other issues prevent or delay the fulfillment of work requirements associated with these key programs. In recent years, our financial results have been adversely affected by revenue declines for our (a) FMS Program due to the government's inability to pass ship transfer legislation and (b) U.S. Army Reserve vehicle and equipment refurbishment work due to government procurement decisions.

The nature of our operations and work performed by our employees present certain challenges related to work force management.

Our financial performance is heavily dependent on the abilities of our operating and administrative staff with respect to technical skills, operating performance, pricing, cost management, safety, and administrative and compliance efforts. A wide diversity of contract types, nature of work, work locations, and legal and regulatory complexities challenges our administrative staff and skill sets. We also face challenges associated with our quality of workforce, quality of work, safety, and labor relations compliance. Our current and projected work in foreign countries exposes us to challenges associated with export and ethics compliance, local laws and customs, workforce issues, extended supply chain, political unrest and war zone threats. Failure to attract or retain an adequately skilled workforce, lack of knowledge or training in critical functions, or inadequate staffing levels can result in lost work, reduced profit margins, losses from cost overruns, performance deficiencies, workplace accidents, and regulatory noncompliance.

Our work on large government programs presents a risk to revenue and profit growth and sustainability.

The eventual expiration of large government programs or the loss of or disruption of revenues on a single contract may reduce our revenues and profits. Such revenue losses could also erode profits on our remaining programs that would have to absorb a larger portion of the fixed corporate costs previously allocated to the expiring programs or discontinued contract work. Our Supply Chain Management Group managed inventory program for USPS, International Group FMS Program, and Federal Group equipment refurbishment program for the U.S. Army Reserve provide significant amounts of revenues and profits, which if interrupted, could adversely impact our overall financial performance.

Acquisitions, which have been a part of our business strategy in recent years, present certain risks.

The decision to acquire a business that subsequently does not meet expected operating and financial performance targets, the failure to make or timely complete an acquisition, the ineffective integration of an acquisition, or the inability of our company to service debt associated with making an acquisition could adversely affect our financial performance.

Global economic conditions and political factors could adversely affect our revenues on current government programs.

Revenues from our government programs for which work is performed in foreign countries are subject to economic conditions in these countries and to political risks posed by ongoing foreign conflicts and potential terrorist activity. A significant amount of our revenues in past years resulted from the U.S. military involvement in Iraq and Afghanistan, and the winding down of this U.S. military involvement has adversely affected our revenues. Also, services performed by our employees on our FMS Program are, to a certain extent, dependent on our placement of employees in a client country. Due to significant domestic and political unrest in Egypt, we have been unable to maintain a consistent level of staffing in that country, resulting in a fluctuating level of services performed by our employees for our Egyptian Navy client. We cannot predict how the Egyptian political situation will unfold or the long range affect it will have on our Egyptian Navy support program. Our Egyptian Navy support services generated revenue of approximately $33 million for 2014 and approximately $48 million for 2013. Global economic and political risks could have an adverse effect on our future revenue levels.

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As a government contractor, we are subject to numerous of procurement rules and regulations that could expose us to potential liabilities or work loss. Additionally, we are exposed to contractual and financial liabilities if our subcontractors do not perform satisfactorily.

We must comply with and are affected by laws and regulations relating to the award, administration and performance of government contracts. Additionally, we are responsible for subcontractor compliance with these laws and regulations. Government contract laws and regulations affect how we conduct business with our customers and, in some instances, impose added costs to us. A violation of laws or regulations could result in the imposition of fines and penalties or the termination of contracts or debarment from working or bidding on government contracts.

In some instances, these government contract laws and regulations impose terms or rights that are significantly more favorable to the government than those typically available to commercial parties in negotiated transactions. For example, the government may terminate any government contract or subcontract at its convenience, as well as for performance default.

A termination for default could expose us to liability and have a material adverse effect on our ability to compete for future contracts and orders. A termination for default could also impact our past performance and ability to win new work. In addition, the government could terminate a prime contract under which we are a subcontractor, irrespective of the quality of services provided by us as a subcontractor.

Additionally, some of our contract work is performed by subcontractors, and such work is subject to government compliance, performance and financial risks. If unsatisfactory performance or compliance failure occurs on the part of subcontractors, we must bear the cost to remedy these deficiencies on our prime contracts.

Due to the nature of our work we could potentially be exposed to legal actions arising from our operations.

Our work includes many manual tasks, including warehousing, shipping and packing of truck parts inventory, maintaining and repairing military and non-military vehicles and equipment, and maintaining and overhauling U.S. Navy ships. Some of our work efforts involve the handling of hazardous materials. This may pose certain challenges that could cause us to be exposed to legal and other liabilities arising from performance issues, work related incidents, or employee misconduct that result in damages, injury or death to third parties (see "Item 3. Legal Proceedings"). Such events could cause us to suffer financial losses and adversely affect our financial condition.

Technology security risks could potentially impact our financial results.

Some of our contract work includes data management and technology services associated with Social Security Administration and military medical and health records. This exposes us to certain information and technology security risks. If there was a security breach of sensitive data in our custody or for which we provide services, we could possibly be held liable for damages to third parties related to such security breach and incur costs to prevent future incidents. Costs associated with preventing or remediating information management security breaches have not had a material adverse effect on our capital expenditures, earnings, or competitive position. However, the occurrence of a future security breach event could potentially have such an adverse effect.

Environmental and pollution risks could potentially impact our financial results.

Some of our contract work includes the use of chemical solvents and the handling of hazardous materials to maintain and refurbish vehicles and equipment. This exposes us to certain environmental and pollution risks. Costs associated with preventing or remediating pollution clean-up efforts and environmental regulatory compliance have not yet had a material adverse effect on our capital expenditures, earnings, or competitive position. However, the occurrence of a future environmental or pollution event could have such an adverse effect.

Investments in facilities could cause losses if certain work is disrupted or discontinued.

We have made investments in facilities and lease commitments to support specific business programs, work requirements, and service offerings. A slowing or disruption of these business programs, work requirements, or

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service offerings that results in operating below intended levels could cause us to suffer financial losses. We incurred charges against operating income of approximately $1.2 million in 2013 and $1.9 million in 2012 associated with the lease of warehouse facilities for our Seized Asset programs.

Our business could be adversely affected by government audits.

Government agencies, including the Defense Contract Audit Agency and the Department of Labor, routinely audit and investigate government contractors. These agencies review a contractor's performance under its contracts, cost structure and compliance with applicable laws, regulations and standards. The government also may review the adequacy of, and a contractor's compliance with, its internal control systems and policies, including the contractor's purchasing, property, estimating, compensation and management information systems. Any costs found to be improperly allocated to a specific contract will not be reimbursed and any such costs already reimbursed must be refunded. If an audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or prohibition from doing business with the government. In addition, we could suffer serious harm to our reputation if allegations of impropriety were made.

New accounting standards could result in changes to our methods of quantifying and recording accounting transactions, and could affect our financial results and financial position.

Changes to generally accepted accounting principles in the United States ("GAAP") arise from new and revised guidance issued by the Financial Accounting Standards Board, the SEC, and others. The effects of such changes may include prescribing an accounting method where none had been previously specified, prescribing a single acceptable method of accounting from among several acceptable methods that currently exist, or revoking the acceptability of a current method and replacing it with an entirely different method, among others. These changes could result in unanticipated effects on results of operations, financial position and other financial measures.

ITEM 1B.

Unresolved Staff Comments

 

None

ITEM 2.

Properties

    

Our executive and administrative headquarters are located in a five-story building in Alexandria, Virginia, with approximately 95,000 square feet of office space leased by us through April 2027.

We own facilities located in an industrial park in Somerset, Pennsylvania that we use to conduct the operations of our subsidiary Wheeler Bros., Inc. These properties consist of approximately 30 acres of land and buildings totaling approximately 212,000 square feet of office, engineering, and warehouse space.

We own and operate two facilities in Ladysmith, Virginia. One of these properties consists of approximately 44 acres of land and multiple storage and vehicle maintenance buildings totaling approximately 56,000 square feet of space. The other property consists of 30 acres of land and buildings totaling approximately 13,500 square feet of space. We also own and operate a facility in Texarkana, Arkansas consisting of approximately 10 acres of land and buildings totaling approximately 79,000 square feet. We use these three properties primarily to provide refurbishment services for military equipment, storage and maintenance.

We also provide services and products from facilities generally occupied under short-term leases primarily located near customer sites to facilitate communications and enhance program performance. As of December 31, 2014, we leased approximately 27 such facilities with a total of approximately 884,000 square feet of office and warehouse space. Our employees often provide services at customer facilities, limiting our requirement for additional space. We also provide services from locations outside of the United States, generally at foreign shipyards or U.S. military installations.

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ITEM 3.

Legal Proceedings

We may have, in the normal course of business, certain claims, including legal proceedings, against us and against other parties. In our opinion, the resolution of these claims will not have a material adverse effect on our results of operations or financial position. However, the results of any claims, including legal proceedings, cannot be predicted with certainty.

On or about May 24, 2012, four complaints were filed in the Circuit Court of the First Circuit, State of Hawaii, by the estates of five deceased individuals and certain of their relatives against VSE and certain other entities and individuals.  The complaints allege, among other things, that the explosion of fireworks and diesel fuel that injured and killed the five individuals on or about April 8, 2011 was caused by negligence, actions and omissions of VSE and the other defendants and their employees, agents and representatives.  The five deceased plaintiffs were employees of Donaldson Enterprises, Inc., which was a vendor retained by VSE to warehouse, store and dispose of fireworks and other explosives seized by the federal government from entities and persons illegally in possession of the fireworks and other explosives. We had a prime contract with the U.S. Department of Treasury ("Treasury") to support the Treasury Executive Office for Asset Forfeiture to manage various seized assets, including management and disposal of fireworks and other explosives seized by various federal government agencies.

We have denied the allegations and, together with our insurance carriers, will aggressively defend the proceedings, which are expected to proceed to trial in 2016. While the results of legal proceedings cannot be predicted with certainty, we do not anticipate that this lawsuit will have a material adverse effect on our results of operations or financial condition.

On or about March 8, 2013, a lawsuit, Anchorage v. Integrated Concepts and Research Corporation, et al., was filed in the Superior Court for the State of Alaska at Anchorage by the Municipality of Anchorage, Alaska against our wholly owned subsidiary Integrated Concepts and Research Corporation ("ICRC") and two former subcontractors of ICRC. Two additional defendants have been added to this litigation. With respect to ICRC, the lawsuit asserts, among other things, breach of contract, professional negligence and negligence in respect of work and services ICRC performed under the Port of Anchorage Intermodal Expansion Contract with the Maritime Administration, a federal agency with the United States Department of Transportation.  On or about April 10, 2013, ICRC removed the case to the United States District Court for the District of Alaska.  This litigation is expected to proceed to trial in 2016. Currently we cannot predict whether the lawsuit will have a material adverse effect on our results of operations or financial condition.

Further, from time-to-time, government agencies investigate whether our operations are being conducted in accordance with applicable contractual and regulatory requirements. Government investigations of us, whether relating to government contracts or conducted for other reasons, could result in administrative, civil or criminal liabilities, including repayments, fines or penalties being imposed upon us, or could lead to suspension or debarment from future government contracting. Government investigations often take years to complete and many result in no adverse action against us.  We believe, based upon current information, that the outcome of any such government disputes and investigations will not have a material adverse effect on our results of operations or financial position.

 

 

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ITEM 4(a).

Executive Officers of Registrant

 

Our executive officers are listed below, as well as information concerning their age and positions held with VSE.  There is no family relationships among any of our executive officers.  For executive officers who have been with us fewer than five years, their principal occupations and business experience during the last five years are provided.  The executive officers are appointed annually to serve until the first meeting of VSE's Board of Directors (the "Board") following the next annual meeting of stockholders and until their successors are elected and have qualified, or until death, resignation or removal, whichever is sooner.

Mr. Harris was appointed President and Chief Operating Officer of Akimeka, LLC in August 2010 immediately following VSE's acquisition of the company. Mr. Harris joined Akimeka LLC in 2001 as Chief Operating Officer. Prior to that, he was president of JJA Enterprises, an independent consulting firm specializing in acquisition, business and financial management, and business development services. Mr. Harris has a Bachelor of Science degree from Middle Tennessee State University and a Master of Science degree in Healthcare Administration from Southwest Texas State University. He also has a Masters equivalent in International Affairs from the Armed Forces Staff College in Norfolk, Virginia.

Mr. Wheeler was appointed President and Chief Operating Officer of Wheeler Bros., Inc. ("WBI"), in July 2013. He is involved in the executive management of day-to-day operations, government contract administration, new business development, supply chain initiatives and facilities management. He serves as a member of the operational board for WBI, and has played an active role at WBI since 1991. Previously, Mr. Wheeler assumed various roles at WBI, including Senior Vice President of Operations, Senior Vice President of Sales and Marketing, and Marketing and Sales Manager. While serving as Marketing and Sales Manager, Mr. Wheeler coordinated implementation of WBI's Managed Inventory Program which is used at the USPS' Vehicle Maintenance Facilities throughout the country. Mr. Wheeler graduated summa cum laude from Indiana University of Pennsylvania in 1998 with a degree in Marketing.

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PART II

 

ITEM 5.

Market for Registrant's Common Equity, Related Stockholder Matters  and Issuer Purchases of Equity Securities

(a)	Market Information

 

VSE common stock, par value $0.05 per share, is traded on The NASDAQ Global Select Market, trading symbol, "VSEC," Newspaper listing, "VSE."

The following table sets forth the range of high and low sales price (based on information reported by The NASDAQ Global Select Market) and cash dividend per share information for our common stock for each quarter and annually during the last two years.

(b)

Holders

As of February 6, 2015, VSE common stock, par value $0.05 per share, was held by approximately 260 stockholders of record.  The number of stockholders of record is not representative of the number of beneficial holders because many of VSE's shares are held by depositories, brokers or nominees.

(c)

Dividends

In 2013 cash dividends were declared quarterly at the annual rate of $0.32 per share through March 31, 2013, and at the annual rate of $0.36 per share commencing June 1, 2013.

In 2014 cash dividends were declared quarterly at the annual rate of $0.36 per share through March 31, 2014, and at the annual rate of $0.40 per share commencing June 1, 2014.

Pursuant to our bank loan agreement (see Note 6, Debt, of "Notes to Consolidated Financial Statements" in Item 8 of this Form 10-K), the payment of cash dividends is subject to annual rate restrictions. We have paid cash dividends each year since 1973 and have increased our dividend each year since 2004.

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(d)	Certain Sales and Repurchases of VSE Common Stock

During the fiscal year covered by this Form 10-K, VSE did not sell any equity securities of VSE that were not registered under the Securities Act of 1933, as amended. During the fourth quarter of the fiscal year covered by this Form 10-K, no purchases of equity securities of VSE were made by or on behalf of VSE or any "affiliated purchaser" (as defined in Exchange Act Rule 10b-18 (a)(3)).

(e)	Equity Compensation Plan Information

We have two compensation plans approved by our stockholders under which our equity securities are authorized for issuance to employees and directors:  (i) the VSE Corporation 2004 Non-Employee Directors Stock Plan and (ii) the VSE Corporation 2006 Restricted Stock Plan (the "2006 Plan"). On May 6, 2014, the stockholders approved amendments to the 2006 Plan extending the term thereof until May 6, 2021 and authorized an additional 250,000 shares of our common stock for issuance under the 2006 Plan.

As of December 31, 2014, 67,075 shares of VSE common stock were available for future issuance under the VSE Corporation 2004 Non-Employee Directors Stock Plan and 278,482 shares of VSE common stock were available for future issuance under the 2006 Plan.

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Performance Graph

Set forth below is a line graph comparing the cumulative total return of VSE common stock with (a) a performance index for the broad market (The NASDAQ Global Select Market) on which VSE common stock is traded and (b) a published industry index. VSE common stock is traded on The NASDAQ Global Select Market, and our industry group is engineering and technical services (formerly SIC Code 8711). Accordingly, the performance graph compares the cumulative total return for VSE common stock with (a) an index for The NASDAQ Global Select Market (U.S. companies) ("NASDAQ Index") and (b) our peer group.

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ITEM 6.    Selected Financial Data

(In thousands, except per share data)

This consolidated summary of selected financial data should be read in conjunction with Management's Discussion and Analysis of the Financial Condition and Results of Operations included in Item 7 of this Form 10-K and with the Consolidated Financial Statements and related Notes included in Item 8 of this Form 10-K. The historical results set forth in this Item 6 are not necessarily indicative of the results of operations to be expected in the future.

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ITEM 7.

Management's Discussion and Analysis of Financial Condition and Results of Operations

 

Customers and Services

We provide sustainment services for legacy systems and equipment and professional and technical services to: the United States Government (the "government"), including the United States Department of Defense ("DoD") and federal civilian agencies; the United States Postal Service ("USPS"); commercial customers; and to other customers. Our largest customers are DoD and USPS. Our operations consist primarily of vehicle fleet parts supply, supply chain management, ship and aircraft maintenance, vehicle and equipment maintenance and refurbishment, logistics, engineering, energy and environmental, IT solutions, health care IT, and consulting services performed on a contract basis. See Item 1 "Business – Revenues and Contracts" on page 6 for revenues by customer.

Acquisition

In January 2015, we acquired four businesses that specialize in maintenance, repair and overhaul ("MRO") services and parts supply for corporate and regional jet aircraft engines and engine accessories. The businesses acquired include Air Parts & Supply Co., Kansas Aviation of Independence, L.L.C., Prime Turbines LLC, and CT Aerospace LLC. These four businesses will operate as a combined group under our newly formed wholly owned subsidiary VSE Aviation, Inc., which has retained certain key management members of the former ownership group.

Organization and Segments

Our operations are conducted within four reportable segments aligned with our management groups: 1) Supply Chain Management; 2) International; 3) Federal; and 4) IT, Energy and Management Consulting. Beginning in 2015, we are consolidating our International and Federal groups into a single management group and one reportable segment. Also beginning in 2015, the newly acquired companies operating under our subsidiary VSE Aviation, Inc. will be included in our current segments or in a new segment.

Supply Chain Management Group – Our Supply Chain Management Group provides sourcing, acquisition, scheduling, transportation, shipping, logistics, data management, and other services to assist our clients with supply chain management efforts. This group consists of our wholly owned subsidiary Wheeler Bros., Inc. ("WBI"). Significant current work efforts for this group include WBI's ongoing USPS Managed Inventory Program ("MIP") that supplies vehicle parts for the USPS truck fleet, other projects to support the USPS, managed inventory services and parts sales to support commercial client truck fleets, and parts sales to DoD.

International Group – Our International Group provides engineering, industrial, logistics, maintenance, information technology, fleet-wide ship and aircraft support, aircraft sustainment and maintenance, facility operations, storage and disposal support for seized and forfeited general property programs, and foreign military sales services to the U.S. military branches, government agencies, and other customers. This group provides its services to the U.S. Navy, Air Force, Department of Justice, Bureau of Alcohol, Tobacco, Firearms and Explosives ("ATF"), and other customers. Current and recent work efforts for this group include assistance to the U.S. Navy in executing its Foreign Military Sales ("FMS") Program for surface ships sold, leased or granted to foreign countries, various task orders under the U.S. Air Force Contract Field Teams ("CFT") Program, and management of seized and forfeited general property programs ("Seized Asset Programs").

Federal Group - Our Federal Group provides engineering, technical, management, and integrated logistics support services to U.S. military branches, government agencies and other customers. These services include full life cycle engineering, logistics, maintenance, field support, and refurbishment services to extend and enhance the life of existing vehicles and equipment; comprehensive systems and software engineering, systems technical support, configuration management, obsolescence management, prototyping services, technology insertion programs, and technical documentation and data packages; and management and execution of government programs under large multiple award contracts. This group provides its services to the U.S. Army, Army Reserve, Marine Corps, and other customers. Significant current work efforts for this group include our ongoing U.S. Army Reserve vehicle refurbishment program and various vehicle and equipment maintenance and sustainment programs for U.S. Army commands.

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IT, Energy and Management Consulting Group – Our IT, Energy and Management Consulting Group consists of our wholly owned subsidiaries Energetics Incorporated ("Energetics") and Akimeka, LLC ("Akimeka"). This group provides technical and consulting services primarily to various DoD and federal civilian agencies, including the United States Departments of Energy, Homeland Security, Commerce, Interior, Labor, Agriculture, and Housing and Urban Development; the Social Security Administration; the Pension Benefit Guaranty Corporation; the National Institutes of Health; customers in the military health system; and other government agencies and commercial clients. Energetics provides technical, policy, business, and management support in areas of energy modernization, clean and efficient energy, climate change mitigation, infrastructure protection, and measurement technology. Akimeka offers solutions in fields that include medical logistics, medical command and control, e-health, information assurance, public safety, enterprise architecture development, information assurance/business continuity, program and portfolio management, network IT services, systems design and integration, quality assurance services, and product and process improvement services.

Concentration of Revenues

Our January 2015 acquisition of four aviation businesses operating under VSE Aviation, Inc. ("VAI") represents a logical next step in our strategy to expand the markets for our sustainment services. We have been performing aircraft maintenance, repair, and overhaul ("MRO") services on our CFT IDIQ contract since 2008, and we have a long history of providing ship and vehicle MRO services to our DoD markets.  Our 2011 acquisition of WBI was our first step in bringing the supply chain element of sustainment in house. Our successful foray into aviation MRO provided us with the platform to enter the aviation supply chain market. The lion's share of  WBI and VAI business extends beyond our traditional markets, and neither depends upon federal budget actions.

The VAI acquisition enhances our range of service offerings, broadens our client base, and decreases our reliance on federal government procurement and budgeting decisions. The addition of these aviation MRO and supply chain management competencies is in furtherance of our long range strategic growth efforts that focus on extending our vehicle, ship, and aircraft sustainment and logistics services to new markets. We are committed to providing value to our clients and optimizing their investment in existing physical assets by assisting them in extending service life and enhancing performance as an attractive alternative to costly replacement. With this aviation acquisition, we expect to become less reliant on DoD with respect to sustaining and growing our revenues.

Managed inventory services centered on vehicle fleet sustainment will continue to be a key service offering of our Supply Chain Management Group. WBI's USPS MIP provides ongoing mission critical supply chain support to the USPS, which provides us with a steady revenue and earnings source. This program does not rely on appropriated government spending, as it is primarily self-funded through revenues generated by USPS business operations.  The USPS is challenged by an aging fleet and constrained vehicle procurement resources. We have been successful in competitively winning work for modifying the existing fleet to address the sharp increase in demand for package delivery. WBI is our largest revenue source and we experienced growth in this program in 2014. Additionally, WBI's managed inventory competency is being successfully marketed to commercial clients operating large vehicle fleets. WBI's successful operating performance has increased the likelihood that certain financial performance thresholds in our acquisition agreement will be met requiring us to make certain post-closing earn-out payments to WBI's sellers. Accordingly, we recorded charges related to this earn-out obligation that offset increases in our Supply Chain Management Group operating income by approximately $3.1 million in 2014. Success in WBI's offerings to both traditional and commercial markets has encouraged us to focus our strategic direction on this part of our business and direct financial and management resources toward such efforts.

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Decreases in government spending for certain programs and services and increased competition for fewer opportunities has led to declines in our DoD and other federal civilian agency revenues. As revenues in our legacy markets have declined, we have responded by taking active measures to adjust our cost structure and operating model to better meet the needs of these markets. We have eliminated certain management positions, consolidated our operations into a fewer number of facilities, and reduced other costs that have supported these activities. Going forward, we will consolidate our International and Federal Groups into a single operating group and report their results as a combined reporting segment beginning in 2015. We expect the cost reductions and consolidation made in the third and fourth quarters of 2014 to provide an estimated annual savings of approximately $4 million. We will continue cost balancing efforts to remain competitive and profitable as we go forward. Despite these challenges to our revenue base, we have key programs in our legacy markets that continue to provide a substantial portion of our business. These programs include our U.S. Navy FMS Program, and our military vehicle and equipment refurbishment work.

Our U.S. Navy FMS Program is our second largest source of revenue. This program does not rely on appropriated government spending as it is largely funded by foreign government clients. Historically, supporting the U.S. Navy in reactivating, transferring and providing follow on technical support to receiving navies constituted the majority of our FMS business. FMS Program revenues for the past few years have been impeded by protracted delays in passing legislation required for the transfer of naval vessels to allied navies. In December 2014, legislation was passed allowing the transfer of certain vessels to selected foreign nations, which is expected to provide us with future FMS Program revenue increases. The revenues associated with these transfers will take time to ramp up, and we expect to begin realizing these revenues in late 2015 and in 2016. Our current contract supporting this work gives us potential contract coverage of up to $1.5 billion over a five-year period that began in January 2012. This contract coverage, combined with the eligibility, upon approval, of U.S. Navy ships for transfer to foreign government clients, presents us with additional revenue opportunities pending future passage of Naval Vessel Transfer Act legislation.

Without the benefit of revenues from vessel transfers in recent years, follow on technical support work has generated the majority of revenues under our FMS Program. These services are provided to several foreign client countries, the largest of which is the Egyptian Navy. Due to significant domestic and political unrest in Egypt, we have been unable to maintain a consistent level of staffing in that country, and accordingly, our revenues associated with follow on technical support services provided to the Egyptian Navy have fluctuated in recent years. Our Egyptian Navy support services generated approximately $33 million of revenue for 2014 and approximately $48 million of revenue for 2013. We believe that our long term relationship with the Egyptian Navy remains strong, and as a result, we anticipate benefiting if the political situation in Egypt stabilizes and U.S. and Egyptian relations improve. We cannot, however, predict how the Egyptian political situation will unfold or the long range affect it will have on our Egyptian Navy support program.

Our vehicle and equipment refurbishment work for the U.S. Army Reserve has been our third largest source of revenue. The U.S. Army Reserve has been adversely affected by DoD and Department of the Army budget reductions, and we have experienced changes to contractual coverage that have adversely affected the flow of work on this program in recent years. This has resulted in a reduction in revenues and lower profit margins on this program compared to previous years. This program generated approximately $48 million of revenue for 2014, a decline from approximately $60 million of revenue for 2013. Contractual coverage on a portion of the work on our current task orders expired in August 2014, and revenue will be lower going forward. Revenue for this program was approximately $8 million for the fourth quarter of 2014. Contractual coverage on our current task orders has been extended for varying periods of time at lower levels, and it remains uncertain how much of this work will be re-competed, continued or extended.

Our work as the prime contractor for the U.S. Department of Treasury Executive Office for Asset Forfeiture general property program ended in 2014, and substantially all of our work on this program was completed as of March 2014. This program generated approximately $9 million of revenue for 2014 and approximately $36 million of revenue for 2013.

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Bookings and Funded Backlog

Revenues for federal government contract work performed by our International, Federal, and IT, Energy and Management Groups depend on contract funding ("bookings"), and bookings generally occur when contract funding documentation is received. Funded contract backlog is an indicator of potential future revenue for these groups. While bookings and funded contract backlog generally result in revenue, occasionally we will have funded contract backlog that expires or is de-obligated upon contract completion and does not generate revenue.

Our Supply Chain Management Group revenues are affected by maintenance schedules and the rate and timing of parts failure on customer vehicles. Bookings for this group occur at the time of sale. Accordingly, this group does not generally have funded contract backlog and it is not an indicator of potential future revenues.

A summary of our bookings and revenues for our International, Federal, and IT, Energy and Management Groups for the years ended December 31, 2014, 2013 and 2012, and funded contract backlog for these groups as of December 31, 2014, 2013 and 2012 is as follows (in millions).

The addition of our acquired aviation businesses and growth of our Supply Chain Management Group revenues is expected to cause our federal government contract revenues to become a smaller proportion of our aggregate revenues in the future. Accordingly, bookings and backlog may become less indicative of future revenues.

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, Revenue from Contracts with Customers, which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The ASU is based on the principle that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to fulfill a contract. The ASU will become effective for us on January 1, 2017. We currently are assessing the impact that this standard will have on our consolidated financial statements.

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and assumptions. We believe the following critical accounting policies affect the more significant accounts, particularly those that involve judgments, estimates and assumptions used in the preparation of our consolidated financial statements.

Revenue Recognition

Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the fee is fixed or determinable, and collectability is probable.

Substantially all of our Supply Chain Management Group revenues result from the sale of vehicle parts to clients. We recognize revenue from the sale of vehicle parts when the customer takes ownership of the parts.

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Substantially all of our International, Federal, and IT, Energy and Management Consulting work is performed for our customers on a contract basis. The three primary types of contracts used are time and materials, cost-type, and fixed-price. Revenues result from work performed on these contracts by our employees and our subcontractors and from costs for materials and other work related costs allowed under our contracts.

Revenue recognition methods on fixed-price contracts will vary depending on the nature of the work and the contract terms. Revenues on fixed-price service contracts are recorded as work is performed, typically ratably over the service period. Revenues on fixed-price contracts that require delivery of specific items are recorded based on a price per unit as units are delivered. We classify our Supply Chain Management Group revenues as fixed-price revenue.

Revenues on cost-type contracts are recorded as contract allowable costs are incurred and fees are earned. Our FMS Program contract is a cost plus award fee contract. This contract has terms that specify award fee payments that are determined by performance and level of contract activity. Award fees are made during the year through a contract modification authorizing the award fee that is issued subsequent to the period in which the work is performed. We recognize award fee income on the FMS Program contract when the fees are fixed or determinable. Due to such timing, and to fluctuations in the level of revenues, profits as a percentage of revenues on this contract will fluctuate from period to period.

Revenues for time and materials contracts are recorded on the basis of contract allowable labor hours worked multiplied by the contract defined billing rates, plus the direct costs and indirect cost burdens associated with materials and subcontract work used in performance on the contract. Generally, profits on time and materials contracts result from the difference between the cost of services performed and the contract defined billing rates for these services.

Revenues by contract type for the years ended December 31 were as follows (in thousands):

We will occasionally perform work at risk, which is work performed prior to formalizing contract funding for such work. Revenue related to work performed at risk is not recognized until it can be reliably estimated and its realization is probable. We recognize this "risk funding" as revenue when the associated costs are incurred or the work is performed. We are at risk of loss for any risk funding not received. Revenues recognized as of December 31, 2014 include approximately $2.9 million for which we had not received formalized funding. We believe that we are entitled to reimbursement and expect to receive all of this funding.

Earn-out Obligations

We utilize the Monte Carlo valuation model for our earn-out obligation. Significant unobservable inputs used to value the contingent consideration include projected earnings before interest, taxes, depreciation and amortization and the discount rate. Interest expense and subsequent changes in the fair value of the earn-out obligations are recognized in earnings for the period of the change.

Goodwill and Intangible Assets

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In the fourth quarter of 2014, we performed our annual goodwill impairment analysis for each of our reporting units. The results of the impairment analysis indicated that the estimated fair values of our reporting units substantially exceeded their carrying values.

As of December 31, 2014, we have no intangible assets with indefinite lives and we had an aggregate of approximately $92 million of goodwill associated with our acquisitions.

Our revenues decreased by approximately $48 million or 10% for the year ended December 31, 2014 as compared to the prior year. The change in revenues for this period resulted from a decrease in our International Group of approximately $41 million; a decrease in our IT, Energy, and Management Consulting Group of approximately $14 million; and a decrease in our Federal Group of approximately $11 million. These decreases were partially offset by an increase in our Supply Chain Management Group of approximately $18 million.

Our revenues decreased by approximately $75 million or 14% for the year ended December 31, 2013 as compared to the prior year. The change in revenues for this period resulted from a decrease in our Federal Group of approximately $47 million; a decrease in our International Group of approximately $20 million and a decrease in our IT, Energy, and Management Consulting Group of approximately $20 million. These decreases were partially offset by an increase in our Supply Chain Management Group of approximately $12 million.

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Contract costs consist primarily of direct costs including labor, inventory, material, and supplies used in the performance of our work and delivery of our products, and indirect costs associated with these direct costs. These costs will generally increase or decrease in conjunction with our level of work or products sold and associated revenues.

Our contract costs decreased by approximately $41 million or 10% in 2014 as compared to 2013. The decrease resulted from a decrease in our International Group of approximately $37 million, a decrease in our IT, Energy, and Management Consulting Group of approximately $11 million, a decrease in our Federal Group of approximately $8 million, and an increase in our Supply Chain Management Group of approximately $15 million.

Our contract costs decreased by approximately $66 million or 14% in 2013 as compared to 2012. The decrease resulted from a decrease in our Federal Group of approximately $39 million, a decrease in our International Group of approximately $21 million, a decrease in our IT, Energy, and Management Consulting Group of approximately $17 million, and an increase in our Supply Chain Management Group of approximately $9 million.

Selling, general and administrative expenses consist primarily of costs and expenses that are not chargeable or reimbursable on our operating unit contracts. These costs increased by approximately $900 thousand for 2014 as compared to the prior year due to legal, consulting, professional services fees and other costs associated with strategic planning efforts, including costs related to the acquisition of our aviation businesses, which was completed in January 2015, of approximately $1.1 million.

Our operating income decreased by approximately $7.2 million or 16% in 2014 as compared to 2013. The decrease resulted primarily from a decrease of approximately $3.3 million in our International Group, a decrease of approximately $2.7 million in our Federal Group, and a decrease of approximately $2.4 million in our IT, Energy and Management Consulting Group. These decreases were partially offset by an increase in operating income in our Supply Chain Management Group of approximately $2.4 million.

Our operating income decreased by approximately $7 million or 14% in 2013 as compared to 2012. The decrease resulted primarily from a decrease in operating income of approximately $8 million in our Federal Group and a decrease in operating income in our IT, Energy and Management Consulting Group of approximately $2.8 million. These decreases were partially offset by an increase in operating income in our Supply Chain Management Group of approximately $3.3 million and an increase in operating income in our International Group of approximately $1 million.

Interest expense decreased in 2014 as compared to 2013, and in 2013 as compared to 2012, due to reductions in our level of borrowing as we paid down our bank loan. Interest expense also includes interest related to our executive and administrative headquarters facility lease. The amount of interest expense associated with capital leases is approximately $1.7 million for 2014, approximately $1.7 million for 2013, and approximately $1.2 million for 2012.

Provision for Income Taxes

Our effective tax rate from continuing operations was 37.8% for 2014, 37.4% for 2013, and 37.6% for 2012.  Our tax rate is affected by discrete items that may occur in any given year, but may not be consistent from year to year. In addition to state income taxes, certain tax credits and other items had an impact on the difference between our statutory U.S. Federal income tax rate of 35% and our effective tax rate. Permanent differences and federal and state tax credits such as the work opportunity tax credit and a state educational improvement tax credit provided a benefit to our tax rates of 1.7% for 2014, 1.9% for 2013 and 1.7% for 2012.

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Supply Chain Management Group Results

The results of operations for our Supply Chain Management Group are (in thousands):

Revenues for our Supply Chain Management Group increased approximately $18 million or 11% for 2014, as compared to the prior year. The revenue increase resulted primarily from an increase in WBI's USPS MIP revenues and to additional revenues associated with other projects performed for the USPS and revenues from new customers. DoD revenues for this group declined slightly in 2014 as compared to the prior year. Contract costs for our Supply Chain Management Group increased by approximately $15 million or 12% for 2014 as compared to the prior year. Operating income for our Supply Chain Management Group increased by approximately $2.4 million or 9% for 2014 as compared to the prior year. Contract cost and operating income increases resulted primarily from the increase in USPS MIP revenues. Operating income for this segment was decreased by approximately $3.1 million in 2014 and by approximately $183 thousand in 2013 due to adjustments to the accrued earn-out obligation associated with our acquisition of WBI.

Revenues for our Supply Chain Management Group increased approximately $12 million or 8% for 2013, as compared to the prior year. The revenue increase resulted primarily from an increase in WBI's USPS MIP revenues of approximately $11.4 million. Contract costs for our Supply Chain Management Group increased by approximately $9 million or 7% for 2013 as compared to the prior year. Operating income for our Supply Chain Management Group increased by approximately $3 million or 14% for 2013 as compared to the prior year. Contract cost, operating income and profit percentage increases resulted primarily from the increase in USPS MIP revenues. Operating income for this segment was decreased by approximately $183 thousand in 2013 and by approximately $802 thousand in 2012 due to adjustments to the accrued earn-out obligation associated with our acquisition of WBI.

International Group Results

The results of operations for our International Group are (in thousands):

Revenues for our International Group decreased approximately $41 million or 28% for 2014, as compared to the prior year. The decrease in revenues for 2014 was primarily attributable to a decrease of approximately $27 million associated with the completion of our U.S. Treasury Seized Assets Program in March 2014, to a decrease of approximately $9 million on our FMS Program, and to smaller decreases in our CFT Program services and other work.

Revenues for our International Group decreased approximately $20 million or 12% for 2013, as compared to the prior year. The decrease in revenues for 2013 was primarily attributable to a decline of approximately $18 million in pass-through work provided on engineering and technical services task orders, and to lesser declines in revenues from our CFT Program services. These decreases were partially offset by increases in revenues on our FMS and Seized Asset Programs.

Contract costs for our International Group decreased approximately $37 million or 27% for 2014, as compared to the prior year. The decrease in contract costs for 2014 was primarily attributable to a decrease of approximately $23 million associated with the completion of our U.S. Treasury Seized Assets Program in March 2014, to a decrease of approximately $8 million on our FMS Program, and to smaller decreases in our CFT Program services and other work.

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Contract costs for our International Group decreased approximately $21 million or 13% for 2013, as compared to the prior year. The decrease in contract costs for 2013 was primarily attributable to a decline of approximately $18 million in pass-through work provided on engineering and technical services task orders, and to lesser declines in revenues from our CFT Program services. These decreases were partially offset by increases on our FMS and Seized Asset Programs.

Operating income for our International Group decreased by approximately $3.3 million or 46% for 2014, as compared to the prior year. The decrease in operating income for 2014 was primarily attributable to a decrease of approximately $3.5 million associated with the completion of our U.S. Treasury Seized Assets Program in March 2014. Our operating income was reduced in 2014 by a charge of approximately $398 thousand for a Department of Treasury claim for an inventory shortage, and was reduced in 2013 by a charge of approximately $1.2 million associated with idle warehouse facilities and a charge of $485 thousand for a Department of Treasury claim for flood damage to vehicles, all of which were associated with our Seized Asset Programs. In 2014, we recovered a net amount of approximately $206 thousand associated with the Department of Treasury vehicle flood damage claim. Profit margins in this group can vary due to fluctuations in contract activity and the timing of contract award fees associated with our FMS Program. Award fee evaluations on our FMS Program occur three times per year and we recognize award fee revenue and income in the period we receive contractual notification of the award. We recognized award fee revenue and income in 2014 from three award fee notifications.

Operating income for our International Group increased by approximately $1 million or 17% for 2013, as compared to the prior year. Our operating income was reduced for these two years by: 1) charges of approximately $1.9 million in 2012 and approximately $1.2 million in 2013 associated with idle warehouse facilities; 2) a charge of $485 thousand in December 2013 for a Department of Treasury claim for flood damage to vehicles; and 3) a loss of $750 thousand in 2012 associated with the final payment on a work share agreement with a subcontractor, all of which were associated with our Seized Asset Programs. The year over year change in operating income was also impacted by an increase in operating income in 2013 associated with the increased revenues on our Seized Asset Programs and the timing of award fee recognition on our FMS Program. We recognized award fee revenue and income in 2013 from three award fee notifications. Due to a catch up of delays in government contractual notification, we recognized revenue and income from four award fees in 2012, including approximately $1.1 million in award fee revenue and income that would typically have been recognized in the prior year. This effectively increased 2012 operating income associated with this program as compared to the typical pattern.

Federal Group Results

The results of operations for our Federal Group are (in thousands):

Revenues for our Federal Group decreased approximately $11 million or 12% for the year ended 2014, as compared to the prior year. The decrease in revenues is primarily due to a reduction in our Army Reserve vehicle refurbishment work of approximately $12 million. Our Army Reserve vehicle refurbishment work decreased as a result of a transition of contractual coverage in the third quarter of 2013 which resulted in a temporary suspension of work and generally lower levels of revenues subsequent to such transition. Additionally, contractual coverage on a portion of the work on our current task orders expired in the third quarter of 2014.

Revenues for our Federal Group decreased approximately $47 million or 33% for the year ended 2013, as compared to the prior year. The decrease in revenues is primarily due to the expiration of a contract at the end of 2012 to provide mechanical maintenance services for Mine Resistance Ambush Protected ("MRAP") vehicles and systems in Kuwait and to a reduction in revenues from our vehicle and equipment refurbishment work for the U.S. Army Reserve due to the suspension of work in the third quarter of 2013. The reduction in revenues due to the expiration of the MRAP contract was approximately $26 million. The reduction in revenues from our vehicle and equipment refurbishment work for the U.S. Army Reserve was approximately $18 million.

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Contract costs for our Federal Group decreased approximately $8 million or 9% for 2014, as compared to the prior year. The decrease in contract costs is primarily due to a reduction in contract costs from our U.S. Army Reserve vehicle refurbishment program of approximately $11 million. We incurred contract costs for increases in other Federal Group work.

Contract costs for our Federal Group decreased approximately $39 million or 29% for 2013, as compared to the prior year. The decrease in contract costs is primarily due to the expiration of the MRAP contract and to a reduction in contract costs from our U.S. Army Reserve vehicle refurbishment program. The reduction in contract costs due to the expiration of the MRAP contract was approximately $24 million. The reduction in contract costs from our vehicle and equipment refurbishment work for the U.S. Army Reserve was approximately $13 million.

Operating income for our Federal Group decreased by approximately $2.7 million or 114% for 2014 as compared to the prior year. The decrease resulted primarily from a reduction of profits on our U.S. Army Reserve program of approximately $1 million due to the reduction in revenues on this program and to the continuation of fixed infrastructure costs during the time that revenue levels have declined.

Operating income for our Federal Group decreased by approximately $8 million or 77% for 2013 as compared to the prior year. The decrease resulted primarily from a reduction of profits on our U.S. Army Reserve program of approximately $5 million due to the reduction in revenues on this program and to the continuation of fixed infrastructure costs during the time that work was suspended, and to a decrease of approximately $2 million in profits associated with the expiration of the MRAP contract. The decrease in the profit percentage in 2013 as compared to 2012 is also primarily due to the continuation of fixed infrastructure costs while work was suspended under the U.S. Army Reserve program.

IT, Energy and Management Consulting Group Results

The results of operations for our IT, Energy and Management Consulting Group are (in thousands):

Revenues for our IT, Energy and Management Consulting Group decreased approximately $14 million or 18% for 2014, as compared to the prior year. Contract costs for our IT, Energy and Management Consulting Group decreased approximately $11 million or 17% for 2014, as compared to the prior year. The decreases in revenues and contract costs were due primarily to a decline in services ordered by clients on continuing contracts and the expiration of a contract in the fourth quarter of 2013. Revenue on the expired contract was approximately $7.6 million for 2013. Operating income for this segment decreased approximately $2.4 million, or 27% for 2014, as compared to the prior year. The decrease in operating income is primarily attributable to the decreases in revenues and lower profit margins associated with new contracts that replaced predecessor contracts, which were partially offset by indirect cost reductions and efficiencies.

Revenues for our IT, Energy and Management Consulting Group decreased approximately $20 million or 21% for 2013, as compared to the prior year. Contract costs for our IT, Energy and Management Consulting Group decreased approximately $17 million or 20% for 2013, as compared to the prior year. The decreases in revenues and contract costs were due primarily to a decrease in services performed due to contract expirations and a decline in services ordered by clients on continuing contracts. Operating income for this segment decreased approximately $2.8 million, or 23% for 2013, as compared to the prior year. The decrease in operating income is primarily attributable to a reduction of $5.1 million in the accrued earn-out obligation associated with our acquisition of Akimeka that increased prior year operating income. There was no earn-out obligation adjustment in 2013. Without the prior year earn-out obligation adjustment, operating income for 2013 would be higher than in the prior year due to improved operating and cost efficiencies.

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Our financial condition did not change materially in 2014. We used our cash flow to reduce our bank debt by approximately $41 million in 2014. Changes to other asset and liability accounts were due primarily to our earnings, our level of business activity, contract delivery schedules, subcontractor and vendor payments required to perform our work, and the timing of associated billings to and collections from our customers.

Cash Flows

Cash and cash equivalents increased by approximately $43 thousand during 2014.

Cash provided by operating activities decreased by approximately $6.9 million in 2014 as compared to 2013. The change is attributable to a decrease of approximately $8.2 million due to changes in the levels of operating assets and liabilities; an increase of approximately $4.8 million in depreciation and amortization and other non-cash operating activities; and a decrease of approximately $3.5 million in cash provided by net income. Our largest operating assets are our accounts receivable and inventories. Our largest operating liabilities are our accounts payable and accrued expenses. A significant portion of our accounts receivable, accounts payable, and inventories result from the use of subcontractors to perform work on our contracts, from the purchase of materials to fulfill our contract requirements, and from the purchase and sale of inventory products. Accordingly, our levels of accounts receivable, accounts payable and inventories may fluctuate depending on the timing of services or products ordered, government funding delays, the timing of billings received from subcontractors and material and inventory vendors, and the timing of payments received from customers in payment of services and products. Such timing differences have the potential to cause increases and decreases in our accounts receivable, accounts payable, and inventories in short time periods. Our levels of accrued expenses tend to vary in accordance with our levels revenues and services performed.

Cash used in investing activities decreased approximately $1.0 million in 2014 as compared to 2013. Cash used in investing activities consisted of purchases of property and equipment.

Cash used in financing activities decreased approximately $7.2 million in 2014 as compared to 2013. Cash used in financing activities consisted primarily of repayments on our bank loan, earn-out obligation payments, and dividends.

Cash provided by operating activities decreased by approximately $3.2 million in 2013 as compared to 2012. The change is attributable to a decrease of approximately $1.2 million due to changes in the levels of operating assets and liabilities; a decrease of approximately $3.6 million in depreciation and amortization and other non-cash operating activities; and an increase of approximately $1.6 million in cash provided by net income.

Cash used in investing activities decreased approximately $21 million in 2013 as compared to 2012. This was primarily due to nonrecurring events in 2012, including cash used of approximately $9 million for capital investments related to the move of our corporate headquarters offices in May 2012 and approximately $9 million to purchase office, warehouse and distribution facilities that support our WBI operations in December 2012.

Cash used in financing activities increased approximately $20 million in 2013 as compared to 2012. This was primarily due to an increase of approximately $26 million in repayments on our bank loan.

We paid quarterly cash dividends totaling approximately $2.0 million or $0.38 per share during 2014. Pursuant to our bank loan agreement, our payment of cash dividends is subject to annual restrictions. We have paid cash dividends each year since 1973 and have increased our dividend each year since 2004.

Liquidity

Our internal sources of liquidity are primarily from operating activities, specifically from changes in the level of revenues and associated accounts receivable and accounts payable, and from profitability. Significant increases or decreases in revenues and accounts receivable and accounts payable can impact our liquidity. Our accounts receivable and accounts payable levels can be affected by changes in the level of the work we perform, by the timing of large materials purchases and subcontractor efforts used in our contracts, the timing of large inventory purchases to support our product offerings, and by government delays in the award of contractual coverage and funding and payments. Government funding delays can cause delays in our ability to invoice for revenues earned, resulting in a negative impact on our days sales outstanding.

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We also purchase property and equipment and invest in expansion, improvement, and maintenance of our operational and administrative facilities. In 2012, we made approximately $9 million in capital investments related to the move of our corporate headquarters offices in May 2012 and in December 2012 we used approximately $9 million to purchase office, warehouse and distribution facilities that support our WBI operations. From time to time, we may also invest in the acquisition of other companies.

Our external financing consists of a loan agreement with a group of banks. In January 2015, we amended and restated the loan agreement to facilitate our acquisition of four aviation businesses. Both the former and the amended and restated loan agreements are comprised of a term loan facility and a revolving loan facility. The revolving loan facility provides for revolving loans and letters of credit. The amended and restated loan agreement expires in January 2020.

The amended and restated term loan requires quarterly installment payments. Our scheduled term loan payments after December 31, 2014 are $11.2 million in 2015, $17.8 million in 2016, $21.6 million in 2017, $28.1 million in 2018, $30 million in 2019, and $41.3 million after 2019. The amount of term loan borrowings outstanding as of December 31, 2014 under the former loan agreement was $25 million. The amount of term loan borrowings outstanding at inception of the amended and restated loan agreement in January 2015 was $150 million.

The maximum amount of credit available to us from the banking group for revolving loans and letters of credit under the former loan agreement as of December 31, 2014 was $125 million. The maximum amount for revolving loans and letters of credit under the amended and restated agreement is $150 million. We may borrow and repay the revolving loan borrowings as our cash flows require or permit. We pay an unused commitment fee and fees on letters of credit that are issued. We had approximately $23.6 million in revolving loan amounts outstanding and no of letters of credit outstanding as of December 31, 2014 under the former loan agreement. The timing of certain payments made and collections received associated with our subcontractor, materials, and inventory requirements and other operating expenses can cause fluctuations in our outstanding revolving loan amounts. Delays in government funding of our work performed can also cause additional borrowing requirements.

Under the amended and restated loan agreement we may elect to increase the maximum availability of the term loan facility, the revolving loan facility, or both facilities up to an aggregate additional amount of $75 million.

We pay interest on the term loan borrowings and revolving loan borrowings at LIBOR plus a base margin or at a base rate (typically the prime rate) plus a base margin. As of December 31, 2014, the LIBOR base margin was 1.75% and the base rate base margin was 0.00%. At inception of the amended and restated loan agreement the LIBOR base margin is 2.25% and the base rate base margin was 1.00%. The base margins increase or decrease in increments as our Total Funded Debt/EBITDA Ratio increases or decreases.

We had interest rate hedges on a portion of our outstanding borrowings that expired June 30, 2014. Between June 30, 2014 and December 31, 2014, we had no interest rate hedges on our outstanding borrowings. The terms of the amended and restated loan agreement require us to have interest rate hedges on a portion of the outstanding term loan for the first three years of the agreement, and for such interest rate hedges to be in place within 60 days after inception of the agreement. We executed such compliant interest rate hedges in February 2015. As of December 31, 2014, interest rates on portions of our outstanding debt range from 1.91% to 3.25%, and the effective interest rate on our aggregate outstanding debt was 3.15%.

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Both the former and amended and restated loan agreements contain collateral requirements to secure our loan agreement obligations, restrictive covenants, a limit on annual dividends, and other affirmative and negative covenants, conditions and limitations. Upon execution of the amended and restated loan agreement, all restrictive covenants and the December 31, 2014 restrictive covenant measurement date under the former loan agreement were replaced by the restrictive covenants under the amended and restated agreement, with the initial measurement date being the date of inception of the amended and restated agreement. Restrictive covenants under the amended and restated loan agreement include a maximum Total Funded Debt/EBITDA Ratio and a minimum Fixed Charge Coverage Ratio, for which calculations as of the amended and restated agreement inception date are shown below. We were in compliance with required ratios and other terms and conditions at inception of the amended and restated loan agreement.

We currently do not use public debt security financing.

Contractual Obligations

Our contractual obligations as of December 31, 2014 are (in thousands):

As of the date of inception of the amended and restated agreement in January 2015, our bank loan debt was $250 million and payments due by period were: $11.2 million in less than one year, $39.4 million in one to three years, $199.4 million in four to five years, and $0 after five years. Estimated cash requirements for interest on our bank loan debt are approximately $6.0 million for 2015 and $4.9 million for 2016.

Operating lease commitments are primarily for leased facilities for office, shop, and warehouse space. Equipment and software leases are also included in these amounts.

We have a 15-year lease agreement whereby lease payments began in May of 2012 for executive and administrative headquarters space. Terms of our lease agreement have required us to capitalize the construction costs of the leased building and account for the lease upon occupancy in May 2012 under the finance method of lease accounting rules.

Purchase obligations consist primarily of contractual commitments associated with our information technology systems. The table excludes contractual commitments for materials or subcontractor work purchased to perform government contracts. Such commitments for materials and subcontractors are reimbursable when used on the contracts, and generally are also reimbursable if a contract is "terminated for convenience" by the government pursuant to federal contracting regulations.

Most of our contracts provide for estimates of future labor costs to be escalated for any option periods, while the non-labor costs in our contracts are normally considered reimbursable at cost. Our property and equipment consists principally of computer systems equipment, furniture and fixtures, shop and warehouse equipment, and land, buildings and improvements. We do not expect the overall impact of inflation on replacement costs of our property and equipment to be material to our future results of operations or financial condition.

 

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ITEM 7A.

Quantitative and Qualitative Disclosures About Market Risks

 

Interest Rates

Our bank loans provide available borrowing to us at variable interest rates. Accordingly, future interest rate changes could potentially put us at risk for a material adverse impact on future earnings and cash flows. To mitigate the risks associated with future interest rate movements we have, at times, used interest rate hedges to fix the rate on portions of our outstanding borrowings. The resulting fixed rates on these portions of our debt is initially higher than the variable rate at the time the hedge is put in place, but gives us protection against future interest rate increases.

As of December 31, 2014, we did not have any interest rate hedges on our debt. In February 2015, we entered into an amortizing LIBOR based interest rate swap on our term loan for a term of four years with a notional amount of $100 million. The swap amount on our term loan decreases in increments on an annual basis. With the term loan swap in place, we pay an effective rate of 1.129% plus our base margin as of February 2015. Also in February 2015, we entered into a LIBOR based interest rate swap on our revolving loan for a term of three years with a notional amount of $25 million. With the revolving loan swap in place, we pay an effective rate of 0.95% plus our base margin as of February 2015.

 

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ITEM 8.

Financial Statements and Supplementary Data

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of VSE Corporation

We have audited the accompanying consolidated balance sheets of VSE Corporation and Subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2014.  These financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of VSE Corporation and Subsidiaries at December 31, 2014 and 2013, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), VSE Corporation and Subsidiaries' internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) and our report dated March 6, 2015 expressed an unqualified opinion thereon.

McLean, Virginia

March 6, 2015

 

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VSE Corporation and Subsidiaries

Consolidated Balance Sheets

(in thousands, except share and per share amounts)

 

The accompanying notes are an integral part of these financial statements.

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VSE Corporation and Subsidiaries

Consolidated Statements of Income

(in thousands, except share and per share amounts)

 

The accompanying notes are an integral part of these financial statements.

 

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VSE Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income

(in thousands)

The accompanying notes are an integral part of these financial statements.

 

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VSE Corporation and Subsidiaries

Consolidated Statements of Stockholders' Equity

(in thousands except per share data)

 

 

The accompanying notes are an integral part of these financial statements.

 

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VSE Corporation and Subsidiaries

Consolidated Statements of Cash Flows

(in thousands)